Singapore Company Guide Edition 1 Version 1 Bloomberg: KREIT SP Reuters: KASA.SI Refer to important disclosures at the end of this report DBS Group Research. Equity 20 Oct 2015 BUY Last Traded Price: S$1.00 (STI : 3,024.50) Price Target : 12-Month S$ 1.12 (12% upside) Potential Catalyst: Better than expected rental reversions and KREIT addressing concerns over its gearing Where we differ: Slighter higher FY16-17F DPU compared to consensus to account for resiliency in KREIT s portfolio given long WALE and prime location of KREIT s properties Analyst Rachael TAN +65 6682 3713 rachaeltan@dbs.com Derek Tan +65 6682 3716 derektan@dbs.com Mervin Song +65 6682 3715 mervinsong@dbs.com Price Relative 1.7 1.5 1.3 1.1 0.9 S$ 0.7 85 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 (LHS) Relative STI INDEX (RHS) Relative Index Forecasts and Valuation FY Dec (S$ m) 2014A 2015F 2016F 2017F Gross Revenue 184 170 175 181 Net Property Inc 151 140 144 149 Total Return 372 172 182 188 Distribution Inc 206 217 226 232 EPU (S cts) 5.5 5.5 5.8 5.9 EPU Gth (%) 0 1 5 2 DPU (S cts) 7.2 6.9 7.1 7.3 DPU Gth (%) (9) (4) 3 2 NAV per shr (S cts) 153.9 139.6 137.7 135.9 PE (X) 18.3 18.2 17.2 16.8 Distribution Yield (%) 7.2 6.9 7.1 7.3 P/NAV (x) 0.6 0.7 0.7 0.7 Aggregate Leverage (%) 43.3 42.6 42.7 42.8 ROAE (%) 3.8 3.9 4.1 4.3 Distn. Inc Chng (%): - - - Consensus DPU (S S cts): 7.0 6.9 6.9 Other Broker Recs: B: 7 S: 4 H: 11 Source of all data: Company, DBS Bank, Bloomberg Finance L.P 205 185 165 145 125 105 YOUNG, MODERN, AND STRATEGICALLY LOCATED OFFICE PORTFOLIO BUY on attractive valuations K-REIT s share price performance has lagged other large cap S- REIT peers in recent months, and we believe it is time to play catch-up as fears of a drop in DPU is already priced in. We have a BUY recommendation on K-REIT, with TP of S$1.12. Modern portfolio should weather office supply wave well While there will be more supply in 2016-2017, we believe that K-REIT s asset portfolio, which comprises some of the most sought-after properties in Singapore will be resilient. In addition, earnings should be shielded to an extent by a long lease expiry profile - 70% of its NLA will only be renewed from 2017. MBFC acquisition to mitigate expiry of OFC income support With the expiry of income support at Ocean Financial Centre (OFC) in 1Q15 and the divestment of Prudential Tower in 3Q14, we have forecasted a 9% decline in DPU in FY15. The decline is partly mitigated by contribution from the recently acquired MBFC Tower 3, although we expect earnings to be flat in FY15-16. Valuation: Our target price of S$1.12 is based on the discounted cash flow (DCF) model, as K-REIT generates recurring rental income from its tenants. At its current price, K-REIT offers investors a dividend yield of 7.1% for FY16F. We have a BUY recommendation. Key Risks to Our View: Shadow space could limit rental growth. Close to 50% of KREIT s leases are from the banking, insurance, and financial sectors. As financial institutions are generally shrinking their footprint, shadow space could be a problem if the Manager is unable to find new tenants to replace them. At A Glance Issued Capital (m shrs) 3,200 Mkt. Cap (S$m/US$m) 3,200 / 2,312 Major Shareholders Keppel Corp (%) 44.8 Free Float (%) 55.2 3m Avg. Daily Val (US$m) 3.2 ICB Industry : Real Estate / Real Estate Investment Trust www.dbsvickers.com ed: JS / sa: JC
CRITICAL DATA POINTS TO WATCH Earnings Drivers: 3Q15 results in line. Distributable income rose 4.6% y-o-y as cessation of income support at OFC was offset by higher contribution from MBFC Tower 3, payment of 100% of management fees in units, as well as S$6m distribution from proceeds from the divestment of Prudential Tower. However 3Q15 DPU fell 6% y-o-y to 1.70 Scts, or -1% q-o-q on the back of an enlarged share base following an EFR exercise to partially fund the acquisition of MBFC Tower 3. FY15 leases substantially secured, working to backfill returned space The Manager has leased out almost all spaces expiring in FY15, with only <1% of its NLA up for renewal or review till the end of the year. K-REIT has been able to achieve average rental reversions of a decent 16% for the 1.1m sqft of leases that it has already forward renewed/ released YTD. This will ensure stability in earnings and distributions over the next 1-2 years. In addition, of the anticipated c.100k sqft of returned spaces that the REIT is exposed to for FY15, c.77% has already been leased out, which gives further visibility to earnings. Low average expiring rents limits downside to rental reversions. Of the 16% of NLA due in FY16, we understand that a substantial portion of leases come from (a) Keppel s own expiries at BJT, (b) one large tenant at OFC, and (c) several first-cycle leases at MBFC Tower 3. The Manager has already begun to approach these tenants with an eye to extending the leases, and given that many of these tenants are sitting on leases with rents still below market. Thus, downside to rents is fairly limited at this point. Long WALE offers income visibility. K-REIT has a long WALE of 6 years, with c.70% of leases due only from FY17F and beyond. Despite the increase in grade A office supply in Singapore by 2016, the Manager remains optimistic on its future outlook as it believes that its assets will continue to be well coveted due to their location in Marina Bay. Coupled with positive rental reversions of 16% in 3Q15, we expect organic rental growth to make up for lost income from the expiry income support at OFC and the divestment of Prudential Tower by 2016. Stable income from Australia K-REIT's Australian properties have a weighted average lease expiry profile of c.10 years, with a majority of leases in built with annual rental escalation clauses, which provides income stability for the REIT. However, contribution in SGD terms has been flat and/or declining, as the value of the AUD has eroded against the SGD. In addition, the currency mismatch between the assets (denominated in AUD) and borrowings (denominated in SGD) has resulted in higher interest expense and gearing ratio. Net Property Income and Margins (%) S$ m 140 85.5% 120 83.5% 100 80 81.5% 60 79.5% 40 77.5% 20 0 75.5% Net Property Income Net Property Income Margin % Quarterly Net Property Income and Margins (%) 86% 41 84% 39 82% 37 80% 35 78% 33 76% 31 74% Net Property Income Net Property Income Margin % ROE (%) 4.0% 3.5% 3.0% 2.5% 2.0% 1.5% 1.0% 0.5% 0.0% Interest Cover (x) (x) 8,000.00 2Q2013 3Q2013 4Q2013 1Q2014 2Q2014 7,000.00 6,000.00 5,000.00 4,000.00 3,000.00 2,000.00 1,000.00 0.00 3Q2014 4Q2014 1Q2015 2Q2015 3Q2015 Page 2
Balance Sheet: Gearing fairly high among peers. At 42.6%, K-REIT has one of the highest gearing among peers. Future acquisitions would therefore likely have to be funded by a mixture of debt and equity. The Manager has implemented a DRP programme as of 2Q15, and will use proceeds to finance its capex requirements, as well as selectively pay down debt. 40.0% 35.0% 30.0% 25.0% 20.0% Aggregate Leverage (%) Long debt tenure minimises refinancing risk. KREIT has a weighted average debt to expiry of 3.6 years in 3Q15, with close to 100% of debt termed out until FY17 and beyond, reducing near term refinancing risk. Share Price Drivers: Addressing gearing levels. We believe that the recent lackluster share price performance could be due to KREIT s higher gearing versus the S-REIT average of c.34%. Given a deteriorating office outlook, investors have been concerned that K-REIT may need to raise equity in order to shore up its balance sheet in the event of a devaluation in office values results in the REIT breeching the 45% gearing limit. While comfortable at current levels, we believe that the Manager could allay some of these concerns through asset sales (Australia properties) where proceeds can be utilised to repay debt. Key Risks: Risks to capital values. Should increase in office supply and a persistently weak office market outlook lead to a larger than expected fall in rents, valuers could downgrade rental and growth outlook, and this could trigger a decline in capital values, which would put the REIT s NAV at risk. Interest rate risk. Any increase in interest rates will result in higher interest payments that the REIT has to make annually to service its loans. While close to 100% of debt margins have been locked in until 2017, higher short term rates would result in higher borrowing costs, given that KREIT has hedged only c.70% of borrowings into fixed-rated debt. Currency risk. As K-REIT earns c.15% of its rental income from its Australian assets in AUD, any depreciation in the AUD would result in relatively lower contributions from Australia to K-REIT's total distributable income. COMPANY BACKGROUND K-REIT is a real estate investment trust investing in predominantly commercial properties in Singapore and key gateway cities in Australia. It currently owns 11 commercial Grade A office assets. 15.0% Distribution Paid / Net Operating CF 5.2 (x) 4.7 4.2 3.7 3.2 2.7 2.2 1.7 1.2 0.7 Distribution Yield (%) (%) 9.3 8.3 +2sd: 8% 7.3 +1sd: 7.2% 6.3 Avg: 6.5% -1sd: 5.7% 5.3-2sd: 5% 4.3 2011 2012 2013 2014 2015 P/Bk NAV (x) (x) 1.3 1.1 +2sd: 1.11x 0.9 +1sd: 0.94x Avg: 0.78x 0.7-1sd: 0.61x 0.5-2sd: 0.45x 0.3 Oct-11 Oct-12 Oct-13 Oct-14 Oct-15 Page 3
Income Statement (S$ m) FY Dec Gross revenue 174 184 170 175 181 Property expenses (36) (33) (30) (31) (32) Net Property Income 138 151 140 144 149 Other Operating expenses (50) (53) (48) (47) (48) Other Non Opg (Exp)/Inc 28 13 3 1 0 Net Interest (Exp)/Inc (18) (23) 0 (2) (3) Exceptional Gain/(Loss) 0 12 0 0 0 Net Income 163 171 177 186 192 Tax (17) (12) (4) (4) (4) Minority Interest 0 0 0 0 0 Preference Dividend 0 0 0 0 0 Net Income After Tax 146 160 172 182 188 Total Return 535 372 172 182 188 Non-tax deductible Items 132 (166) 45 43 43 Net Inc available for Dist. 214 206 217 226 232 Growth & Ratio Revenue Gth (%) 10.9 5.8 (7.5) 2.6 3.3 N Property Inc Gth (%) 10.9 9.5 (7.3) 2.7 3.4 Net Inc Gth (%) 25.5 9.4 8.0 5.8 3.2 Dist. Payout Ratio (%) 100.0 100.0 100.0 100.0 100.0 Net Prop Inc Margins (%) 79.5 82.3 82.4 82.4 82.5 Net Income Margins (%) 83.8 86.7 101.2 104.3 104.3 Dist to revenue (%) 123.0 112.0 127.4 129.0 128.2 Operating expenses (%) 28.6 28.8 28.0 27.1 26.3 ROAE (%) 4.0 3.8 3.9 4.1 4.3 ROA (%) 2.3 2.3 2.3 2.5 2.5 ROCE (%) 1.3 1.3 1.2 1.3 1.4 Int. Cover (x) 4.9 4.3 7,383.9 46.2 29.0 We expect distributions to remain fairly stable going forward, as KREIT s portfolio average rents are below market, which limits downside from negative reversions Page 4
Quarterly / Interim Income Statement (S$ m) FY Dec 3Q2014 4Q2014 1Q2015 2Q2015 2015 3Q2015 Gross revenue 48 42 42 41 42 Property expenses (9) (8) (8) (8) (9) Net Property Income 39 34 35 33 33 Other Operating expenses (12) (11) (15) (14) (15) Other Non Opg (Exp)/Inc (5) 2 2 4 1 Net Interest (Exp)/Inc (7) (6) (7) (7) (8) Exceptional Gain/(Loss) 16 0 0 0 0 Net Income 50 39 38 39 35 Tax (4) (3) (2) (2) (4) Minority Interest 0 0 0 0 0 Net Income after Tax 46 36 37 37 30 Total Return 138 156 37 37 51 Non-tax deductible Items (86) (110) 18 18 3 Net Inc available for Dist. 52 46 54 55 54 Growth & Ratio Revenue Gth (%) 1 (11) 0 (4) 3 N Property Inc Gth (%) (2) (11) 1 (6) 3 Net Inc Gth (%) 22 (21) 1 2 (19) Net Prop Inc Margin (%) 80.9 80.9 81.6 79.8 79.2 Dist. Payout Ratio (%) 100.0 100.0 100.0 100.0 100.0 Growth in distributable income as (a) new contribution from MBFC Tower 2, (b) payment of 100% of management fees in units, and (c) a one-off distribution from gains following the sale of Prudential Tower, mitigated the decline in income due to the cessation of income support at OFC, and higher interest expense Balance Sheet (S$ m) FY Dec Investment Properties 4,015 3,614 3,614 3,614 3,614 Other LT Assets 2,635 3,490 3,533 3,533 3,533 Cash & ST Invts 91 200 244 221 198 Inventory 0 0 0 0 0 Debtors 34 25 28 29 30 Other Current Assets 1 1 1 1 1 Total Assets 6,776 7,329 7,420 7,397 7,375 ST Debt 282 275 295 295 295 Creditor 94 84 100 102 105 Other Current Liab 23 21 18 17 17 LT Debt 2,401 2,390 2,473 2,473 2,473 Other LT Liabilities 76 99 99 99 99 Unit holders funds 3,897 4,457 4,433 4,409 4,384 Minority Interests 2 2 2 2 2 Total Funds & Liabilities 6,776 7,329 7,420 7,397 7,375 Non-Cash Wkg. Capital (82) (80) (88) (90) (92) Net Cash/(Debt) (2,592) (2,466) (2,523) (2,547) (2,569) Ratio Current Ratio (x) 0.3 0.6 0.7 0.6 0.5 Quick Ratio (x) 0.3 0.6 0.7 0.6 0.5 Aggregate Leverage (%) 42.9 43.3 42.6 42.7 42.8 Z-Score (X) 0.8 0.8 0.8 0.8 0.8 Gearing should remain fairly stable as capex requirements are funded using proceeds from DRP, minimising additional debt obligations Page 5
Cash Flow Statement (S$ m) FY Dec Pre-Tax Income 163 171 177 186 192 Dep. & Amort. 0 0 0 0 0 Tax Paid (15) (14) (8) (4) (4) Associates &JV Inc/(Loss) (64) (71) (81) (91) (95) Chg in Wkg.Cap. (45) (74) 12 2 2 Other Operating CF 23 30 21 18 19 Net Operating CF 60 43 121 112 114 Net Invt in Properties 504 504 0 0 0 Other Invts (net) 0 0 0 0 0 Invts in Assoc. & JV (585) (585) (42) 0 0 Div from Assoc. & JVs 65 73 81 91 95 Other Investing CF (208) 100 0 0 0 Net Investing CF (224) 92 39 91 95 Distribution Paid (211) (215) (217) (226) (232) Chg in Gross Debt 258 (21) 102 0 0 New units issued 173 225 0 0 0 Other Financing CF (55) (57) 0 0 0 Net Financing CF 165 (67) (115) (226) (232) Currency Adjustments (12) 42 0 0 0 Chg in Cash (11) 109 45 (23) (23) Operating CFPS (S cts) 4.0 4.0 3.5 3.5 3.6 Free CFPS (S cts) 21.1 18.7 3.9 3.6 3.6 Target Price & Ratings History S$ 1.32 1.27 1.22 1.17 1.12 1.07 S.No. Da te Closing Ta rge t Price Price Ra ting 1: 21 Jan 15 1.24 1.29 HOLD 2: 14 Apr 15 1.23 1.32 BUY 3: 21 Jul 15 1.12 1.32 BUY 4: 19 Aug 15 1.11 1.12 BUY 1.02 0.97 0.92 0.87 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Note : Share price and Target price are adjusted for corporate actions. Source: DBS Bank Page 6
` S$ 1.32 1.27 1.22 1.17 1.12 1.07 1.02 1 2 3 4 S.No. Da te Closing Ta rge t Price Price Ra ting 1: 21 Jan 15 1.24 1.29 HOLD 2: 14 Apr 15 1.23 1.32 BUY 3: 21 Jul 15 1.12 1.32 BUY 4: 19 Aug 15 1.11 1.12 BUY 0.97 0.92 0.87 Oct-14 Dec-14 Feb-15 Apr-15 Jun-15 Aug-15 Oct-15 Note : Share price and Target price are adjusted for corporate actions. Page 7
DBS Bank recommendations are based an Absolute Total Return* Rating system, defined as follows: STRONG BUY (>20% total return over the next 3 months, with identifiable share price catalysts within this time frame) BUY (>15% total return over the next 12 months for small caps, >10% for large caps) HOLD (-10% to +15% total return over the next 12 months for small caps, -10% to +10% for large caps) FULLY VALUED (negative total return i.e. > -10% over the next 12 months) SELL (negative total return of > -20% over the next 3 months, with identifiable catalysts within this time frame) Share price appreciation + dividends GENERAL DISCLOSURE/DISCLAIMER This report is prepared by DBS Bank Ltd. This report is solely intended for the clients of DBS Bank Ltd and DBS Vickers Securities (Singapore) Pte Ltd, its respective connected and associated corporations and affiliates (collectively, the DBS Vickers Group ) only and no part of this document may be (i) copied, photocopied or duplicated in any form or by any means or (ii) redistributed without the prior written consent of DBS Bank Ltd. The research set out in this report is based on information obtained from sources believed to be reliable, but we (which collectively refers to DBS Bank Ltd., its respective connected and associated corporations, affiliates and their respective directors, officers, employees and agents (collectively, the DBS Group )) do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate independent legal or financial advice. The DBS Group accepts no liability whatsoever for any direct, indirect and/or consequential loss (including any claims for loss of profit) arising from any use of and/or reliance upon this document and/or further communication given in relation to this document This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. The DBS Group, along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. The DBS Group may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking services for these companies. Any valuations, opinions, estimates, forecasts, ratings or risk assessments herein constitutes a judgment as of the date of this report, and there can be no assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments. The information in this document is subject to change without notice, its accuracy is not guaranteed, it may be incomplete or condensed and it may not contain all material information concerning the company (or companies) referred to in this report. The valuations, opinions, estimates, forecasts, ratings or risk assessments described in this report were based upon a number of estimates and assumptions and are inherently subject to significant uncertainties and contingencies. It can be expected that one or more of the estimates on which the valuations, opinions, estimates, forecasts, ratings or risk assessments were based will not materialize or will vary significantly from actual results. Therefore, the inclusion of the valuations, opinions, estimates, forecasts, ratings or risk assessments described herein IS NOT TO BE RELIED UPON as a representation and/or warranty by the DBS Group (and/or any persons associated with the aforesaid entities), that: (a) such valuations, opinions, estimates, forecasts, ratings or risk assessments or their underlying assumptions will be achieved, and (b) there is any assurance that future results or events will be consistent with any such valuations, opinions, estimates, forecasts, ratings or risk assessments stated therein. Any assumptions made in this report that refers to commodities, are for the purposes of making forecasts for the company (or companies) mentioned herein. They are not to be construed as recommendations to trade in the physical commodity or in the futures contract relating to the commodity referred to in this report. DBS Vickers Securities (USA) Inc ("DBSVUSA")"), a U.S.-registered broker-dealer, does not have its own investment banking or research department, nor has it participated in any investment banking transaction as a manager or co-manager in the past twelve months. ANALYST CERTIFICATION The research analyst primarily responsible for the content of this research report, in part or in whole, certifies that the views about the companies and their securities expressed in this report accurately reflect his/her personal views. The analyst also certifies that no part of his/her compensation was, is, or will be, directly, or indirectly, related to specific recommendations or views expressed in this report. As of the date the report is published, the analyst and his/her spouse and/or relatives who are financially dependent on the analyst, do not hold interests in the securities recommended in this report ( interest includes direct or indirect ownership of securities). COMPANY-SPECIFIC / REGULATORY DISCLOSURES 1. DBS Bank Ltd., DBS Vickers Securities (Singapore) Pte Ltd ( DBSVS ), their subsidiaries and/or other affiliates have a proprietary position in the recommended in this report as of 31 Aug 2015 2. DBS Bank Ltd., DBSVS, DBSVUSA, their subsidiaries and/or other affiliates may beneficially own a total of 1% of any class of common equity securities of the company mentioned as of 31 Aug 2015. 3. Compensation for investment banking services: DBS Bank Ltd., DBSVS, DBSVUSA, their subsidiaries and/or other affiliates may have received compensation, within the past 12 months, and within the next 3 months may receive or intends to seek compensation for investment banking services from the company mentioned. Page 8
DBSVUSA does not have its own investment banking or research department, nor has it participated in any investment banking transaction as a manager or co-manager in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively. RESTRICTIONS ON DISTRIBUTION General This report is not directed to, or intended for distribution to or use by, any person or entity who is a citizen or resident of or located in any locality, state, country or other jurisdiction where such distribution, publication, availability or use would be contrary to law or regulation. Australia Hong Kong Indonesia Malaysia This report is being distributed in Australia by DBS Bank Ltd. 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